TERRAFORMING TERRA
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Tuesday, June 24, 2014

Massive Chinese Steel Glut

For
those who like to worry, we have the massive expansion of Chinese
steel making capacity. This picture has been discordant for a very
long time and leaves me wondering if we are all missing something.
The reason that I ask that is that central planning types have a
clear picture of what their building objectives are. If that means a
cement slab condo for every family in 2030, then warehousing millions
of tons of re-bar is plausible and easily financed with low interest
money.

Thus
this massive build out may merely reflect future capital outlays and
financing structures not sold yet. These so called ghost cities may
be empty today, but they can sit idle for years. A cheap renovation
later and they are back in the market. They are concrete after all.

I
would feel much better though to see the same so called reckless
building going on in India as well.

The
deformations in the global economy arising from the central bank
fueled credit deluge of the last two decades become more visible and
foreboding by the day. One vector of special salience is the global
iron ore market where prices have now punctured the $100 per ton mark
to $94, and are down 50% from a peak of $200 in 2012.

The
action here is not just another commodity cycle, but instead is a
proxy for the global credit bubble, China department.

During
the course of its mad scramble to become the world’s export factory
and then its greatest infrastructure construction site, China’s
expansion of domestic credit broke every historical record and has
ultimately landed in the zone of pure financial madness. To wit,
during the 14 years since the turn of the century China’s total
debt outstanding–including its vast, opaque, wild west shadow
banking system—soared from $1 trillion to $25 trillion, and from 1X
GDP to upwards of 3X.

But
these “leverage ratios” are actually far more dangerous and
unstable than the pure numbers suggest because
the denominator—national income or GDP—-has been erected on an
unsustainable frenzy of fixed asset investment. Accordingly,
China’s so-called GDP of $9 trillion contains a huge component of
one-time spending that will disappear in the years ahead, but which
will leave behind enormous economic waste
and monumental over-investment that will result
in sub-economic returns and write-offs for years to come.

Nearly
every year since 2008, in fact, fixed asset investment in public
infrastructure, housing and domestic industry has amounted to nearly
50% of GDP. But that’s not just a case of extreme of growth
enthusiasm, as the Wall Street bulls would have you believe.
It’s actually indicative of an economy of 1.3 billion people
who have gone made digging, building, borrowing and speculating.

Nowhere
is this more evident than in China’s vastly overbuilt steel
industry, where capacity has soared from about 100 million tons in
1995 to upwards of 1.2 billion tons today. Again, this 12X growth in
less than two decades is not just red capitalism getting
rambunctious; its actually an economically cancerous deformation that
will eventually dislocate the entire global economy. Stated
differently, the 1 billion ton growth of China’s steel industry
since 1995 represents 2X the entire capacity of the global steel
industry at the time; 7X the size of Japan’s then world champion
steel industry; and 10X the then size of the US industry.

Already,
the evidence of a thundering break-down of China’s steel industry
is gathering momentum. Capacity utilization has fallen from 95% in
2001 to 75% last year, and will eventually plunge toward 60% and a
half billion tones of excess capacity. Likewise, even the manipulated
and massaged financial results from China big steel companies have
begin to sharply deteriorate. Profits have dropped from $80-100
billion RMB annually to 20 billion in 2013, and are now in the
red; and the reported aggregate leverage ratio of the industry has
soared to in excess of 70%.

But
these are just mild intimations of what is coming. The hidden truth
of the matter is that China would be lucky to have even 500 billion
of annual “sell-through” demand for steel to be used in
production of cars, appliances, industrial machinery and for normal
replacement cycles of long-lived capital assets like office towers,
ships, shopping malls, highways, airports and rails.

Stated
differently, upwards of 50% of the 800 million tons of steel produced
by China in 2013 likely went into one-time demand from the frenzy in
infrastructure.

Indeed,
the deformations are so extreme that on the margin China’s steel
industry has been chasing its own tail like some stumbling, levered
dragon. Thus, demand for plate steel to build dry bulk carriers has
soared, but the underlying demand for new capacity was, ironically,
driven by bloated demand for the iron ore needed to make the steel to
build China’s empty apartments and office towers and unused
airports, highways and rails.

In
short, when the credit and building frenzy stops, China will be
drowning in excess steel capacity and will try to export its way out—
flooding the world with cheap steel. A trade crisis will soon ensue,
and we will shortly have the kind of globalized import quota system
that was imposed on Japan in the early 1980s. Needless to say, the
latter may stabilize steel prices at levels far below current quotes,
but it will also mean a drastic cutback in global steel production
and iron ore demand.

And
that gets to the second half of the deformation arising from central
bank fueled credit expansion and the drastic worldwide repression of
interest rates and cost of capital. The 12X expansion of China’s
steel industry was accompanied by an even more fantastic expansion of
iron ore production, processing, transportation, port and ocean
shipping capacity.

On
the one hand, capacity could not grow at the breakneck speed of
China’s initial ramp in steel production—so prices soared. And
again, not just in the range of traditional cyclical amplitudes. In
fact, prices rose from $20 per ton in the early 1990s to $200 per ton
by 2012—meaning that vast windfall rents were earned on the
difference between low cash costs on existing or recently constructed
iron ore capacity and the soaring prices in spot and contract
markets.

The
reality of truly obscene current profits and the propaganda about
endless growth in the miracle of red capitalism, combined with the
cheap debt available in global capital markets, resulted in an
explosion of iron ore mining capacity like the world has never before
witnessed in any mineral industry. The attached story on the massive
new capacity still coming on-stream in western Australia provides a
dramatic picture of how far this got out of hand.

So
the mother of all commodity bubble collapses is virtually baked into
the cake. As one CEO quoted in the story makes clear, his cash cost
of production is about $20 per ton and he will not hesitate to keep
producing for positive variable profit. That means iron ore prices
will also plunge far below the current $94 per ton quote.

In
short, when the classical economists talked about “malinvestment”
the pending disasters in the global steel and iron ore industries
(and also mining equipment and other supplier industries) are what
they had in mind. Except none of them could have imagined the fevered
and irrational magnitudes of the deformations that have resulted from
the actions of the mad money printers who now run the world’s
central banks.

By
Phoebe Sedgman and Jesse Riseborough at Bloomberg News

Iron
oreshipments
from Australia’s
Port
Hedlandexpanded
to a record in May as mining companies boosted output, helping to
push benchmark prices to the lowest level since 2012 and contributing
to a rising global surplus.

Exports
from the world’s largest bulk export terminal surged to 36.1
million metric tons from 34.8 million tons in April and 27.9 million
tons in May 2013, data on the port
authority’s
website showed today. Shipments to China were
a record 29.9 million tons in May compared with 28.9 million tons in
April and 23.3 million tons a year earlier, the data showed.

Producers
in the world’s largest shipper including BHP Billiton Ltd. And
Fortescue
Metals Group Ltd. (FMG)are
expanding supplies, betting that increased volumes from low-cost
mines will more than offset declining prices. The raw material capped
a sixth monthly drop in May in the longest losing run on record. Iron
ore could extend declines over the next year, according to Fortescue
Chairman Andrew
Forrest,
and Australia & New Zealand Banking Group Ltd. cut its price
forecasts today.

“Miners
are lifting output,” said Justin Smirk, a senior economist at
Westpac Banking Corp. in Sydney. “As long as iron ore remains at a
price where miners can deliver it at a profit, it may be a shrinking
profit, but if they’re still making money they’ll keep”
producing, he said.

Iron
ore with 62 percent content delivered to the port of Tianjin advanced
2.3 percent to $94.60 a dry ton today, according to The Steel Index
Ltd. Prices have slumped 30 percent this year, reaching $91.80 on May
30, the lowest since Sept. 7, 2012. They could drop as low as $80 or
rise as high at $140 over the next 12 months, Forrest said in
Melbourne on May 30.

Global
Glut

The
global seaborne surplus will jump from 14 million tons last year to
72 million tons in 2014 and 175 million tons in 2015, Goldman Sachs
Group Inc. said in a May 20 report. Worldwide supplies will expand 10
percent in 2014, outstripping the 3.7 percent rise in demand, Morgan
Stanley predicts.

A
further slide in the price would place competitors under pressure,
Rio
Tinto (RIO)Group
Chief Executive Officer Sam
Walshsaid
in an interview with Bloomberg Television yesterday, describing $80
as too low. Rio is the second-biggest producer and last year derived
about 88 percent of earnings from the commodity.

“We
are the lowest-cost producer in the world, with costs of $20 per ton
compared to the price around $92 a ton; I think we’ll be OK,” the
64-year-old Australian said. “I don’t think we’re going to go
down to $80 or else a lot of my friendly competitors are going to
disappear.”

‘Socks
Off’

In
the first five months of the year, iron ore exports from Port Hedland
totaled 161.3 million tons, 34 percent higher than the same period in
2013, according to Bloomberg calculations based on port data.
Shipments to China surged 36 percent to 130.5 million tons in the
January-to-May period.

“Our
miners are exporting their socks off and thank God because it’s
having an impact, a positive impact, on our economy,” Treasurer Joe
Hockeytold
reporters in Canberra today after the release of government figures
that showed the economy grew at the fastest pace in two years in the
first quarter.

“Growth
has been driven unquestionably by net exports,” said Hockey. “But
what we found over this March quarter, it’s an extraordinary
quarter in March when you don’t have cyclones, particularly in
Western
Australiaaffecting
Port Hedland.”

While
iron ore looks oversold and may rebound as much as 15 percent in the
coming months, average prices may be less than previously forecast
from this year through 2016, ANZ said in separate reports. Prices may
average $110 a ton this year from a previous estimate of $120, and
$106 in 2015 from $118, it said. Increased Australian output will
hurt higher-cost Chinese supplies, establishing a new floor price at
about $100, it said.

Strike
Threat

Tugboat
workers have approved work stoppages at Port Hedland, risking
disruptions BHP estimates may cost suppliers A$100 million ($93
million) a day. BHP, Fortescue, Australia’s third-largest producer,
and Atlas
Iron Ltd. (AGO) all
ship output from the Pilbara region through the facility in Western
Australia, while Rio Tinto exports through Cape Lambert and Dampier.

The
Australian Maritime Officers Union and the Maritime Union of
Australia have approved strikes against Teekay Shipping (Australia)
Pty in Port Hedland. A third union, the Australian Institute of
Marine and Power Engineers is balloting members and expects results
from its workers on June 10.

Iron
ore stockpiles at
ports in China, the world’s largest steelmaker, increased for an
eighth month in May, reaching a record 106.86 million tons last week,
according to Beijing Antaike Information Development Co.

Mine
Expansions

Fortescue
said April 16 it completed an expansion to nearly triple capacity to
155 million tons, while BHP in April raised its full-year output
estimate 2.4 percent to 217 million tons after third quarter output
surged. Rio said on April 15 that the expansion of its capacity to
360 million tons a year is on track for completion by the end of the
first half of next year.

“We
are confident with our projections that as we go forward the
expansions that we’re making will be justified,” said Rio’s
Walsh. “I think that $80 is too low, I suspect a level somewhere
north of $100 is probably more realistic.”

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About Me

Jan 2015 - 3 Mil Pg Views, March 2013 - Posted my paper introducing CLOUD COSMOLOGY & NEUTRAL NEUTRINO rigorously described, September 2010 I am pleased to report that my essay titled A NEW METRIC WITH APPLICATIONS TO PHYSICS AND SOLVING CERTAIN HIGHER ORDERED DIFFERENTIAL EQUATIONS' has been published in Physics Essays(AIP) and appeared in their June 2010 quarterly. 40 years ago I took an honors degree in applied mathematics from the University of Waterloo. My interest was Relativity and my last year there saw me complete a 900 level course under Hanno Rund on his work in relativity,as well as differential geometry(pure math) and of course analysis. I continued researching new ideas and knowledge since that time and I have prepared a book for publication titled 'Paradigms Shift'. I maintain my blog as a day book and research tool to retain data and record impressions and interpretations on material read. Do join my blog and receive Four items of interest daily Monday through Saturday.